One cannot avoid tax on short-term capital gains. However, one can claim deductions to lower the tax liability on long-term gains. Section 54 under Indian Income Tax Act, 1961 defines ways to save capital gain subject to fulfillment of certain conditions.
Buying or building a new house:
Capital Gain under section 54 can be used to save up to the amount used for buying or constructing new house. The deduction allowed is equal to the actual investment or the LTCG (Long Term Capital Gain), whichever is lower. If the amount of capital gain is greater than the amount buying a new house, the remaining amount of capital gain will be taxed.
The assessee should not own more than one residential house, other than the new asset, on the date of transfer of the original asset.
The new house has to be bought one year before the transfer of the first house or within two years after the sale. If LTCG (Long Term Capital Gain) are used to build a house, it has to be done within three years of the sale of the property. If a plot is purchased to build a house, the cost of plot is included in the construction cost.
The tax deduction can also be availed on buying of an under-construction property. One can buy an under-construction apartment to save capital gains tax, provided its construction is completed within three years of the transfer of the first property.
If the new property is sold within three years of purchase or construction, the deduction is reversed and taxed as short-term capital gain.
Capital Gains Account scheme (CGAS)
Buying or constructing a house generally takes a long time. Individuals and members of HUF (Hindu Undivided Family) can benefit from Capital Gains Account scheme (CGAS).
Taxpayers can avail exemptions under the CGAS only when the amount of capital gain, or net consideration, is deposited by the last date for filing the income tax return (July 31). You will have to attach the proof of the deposit with your return.
CGAS is nothing more than a parking place for the capital gain, where one can deposit money until one buys a new house or constructs a house.
The deposited money can be used only to buy or construct a residential house within the prescribed time frame. Failure to do so will lead to taxation of the un-utilised amount as long-term capital gain after three years of the sale of the first property.
For instance, let’s say, I sold a property in April 2011. The capital gain made should be used to either buy a house by April 2013 or construct a house by 2014. Until then, I can deposit the money in a CGAS account before the date of filing returns, which in this case was be July 31 2012, to save tax. If I do not acquire(buy or build) the new property till April 2014, the LTCG (Long Term Capital Gain) would be taxable in the fiscal year 2014-15.
Investing in Notified Bonds
Capital gains from sale of any long-term asset can be claimed as tax-exempt under Section 54EC of the Income-Tax Act by investing in notified bonds within six months of its transfer.
These bonds are issued by the Rural Electrification Corporation and the National Highways Authority of India. The exemption is equal to the investment or the capital gain, whichever is lower.
To get the tax benefit, you have to hold these bonds for at least three years. If you transfer or take a loan against these bonds within three years, the capital gain will become taxable. The benefit is allowed to the extent of the amount invested.
One can invest a maximum of INR 50,00,000/- during a financial year (April-March) in these bonds. In fact, one could time the sale of house property in such a way that this period of six months actually falls between two fiscal years. So, if one sell the house between October and March, one comes in the six months limit between two fiscal years. In that case, one can invest Rs. 10,000,000/- (One crore) in total over two financial years and get the tax benefit.
When LTCG (Long Term Capital Gain) Is Not Taxed
When one sells farm land, one doesn’t have to pay any capital gains tax on the profit earned. The exemption is not valid if the land is within the limits of a civic body (municipality, municipal corporation, town committee or a cantonment board) with a population of 10,000 or more at the beginning of the previous year. It also does not apply if the land is within 8 km of such civic limits.
If one has made capital gains from sale of land used for agricultural purposes (by the assessee or his/her parents) for at least two years before the transfer date, the money can be invested in any land for agriculture. The invested amount then becomes eligible for deduction. The exemption is withdrawn if you buy another land within two years of the deduction.
To save long term capital gain the seller has to buy a house property within two years of sale of capital asset or construct a house within three years. If seller is not able to identify a property he/she can open a capital gain accounting scheme’s special account and park the money until he finds the property (with limit of 3 years). Seller also can invest money in specific bond up to limit of Rs 50 Lakhs to save LTCG tax.